Using capital market assumptions for future-focused investing

In today’s fast-moving financial landscape, it’s easy to get caught up in the headlines – quarterly earnings surprises, political developments, or shifting market sentiment, to name a few. These factors can all affect investment performance in the short term. But for pension customers focused on the long term, this can be distracting – in fact, there is often a disconnect between short-term performance and long-term strategy.

That’s where capital market assumptions (CMAs) come in – a foundational input of our asset allocation approach, to provide a structured, forward-looking view of expected returns, risks, and correlations across asset classes over a long-term horizon.

In this article, we’ll walk through our approach to creating CMAs and examine how they’ve stood the test of market conditions this year. Ultimately, we’ll highlight why CMAs remain a cornerstone of our asset allocation approach.

Our approach to capital market assumptions

We calculate our CMAs in-house, enabling us to incorporate the views of our asset allocation experts. Our CMAs consider asset class risks and interactions and are compared against market expectations and economic indicators. This isn’t a static process – we update our CMAs quarterly as part of our asset allocation modelling, and we’re ready to make ad-hoc changes when markets move sharply or volatility spikes. And each year, we survey external CMA forecasts to compare assumptions, helping us identify where our views differ – whether we’re more bullish or bearish – and challenge ourselves accordingly.

We feed our CMAs into market-leading software to derive an efficient frontier, representing the highest expected returns for each level of risk. From this, we select a point as close as possible to the leading risk profilers in the market. We also work with partners to understand forward-looking risks, factor exposures, and potential stresses to fine tune our positioning. Together, these comprise our asset allocation approach.

Do capital market assumptions add value?

We recognise that growth assumptions are inherently subjective, and will always involve a degree of uncertainty. But starting bond yields and dividend yields are strong predictors of future returns. These provide a more objective foundation for our assumptions, even if the growth component remains more interpretive.

More broadly though, while short-term forecasts are often swayed by sentiment and market noise, long-term forecasts offer a more stable and useful guide for strategic positioning, helping us stay grounded in our long-term perspective, even when markets are volatile.

Reviewing Our CMAs for 2025

At the beginning of 2025, we outlined three key assumptions. Below, we revisit each one in light of how market conditions have evolved since then.

1. The US market is unlikely to experience the same Trump rally as 2016

When creating this assumption at the start of 2025, the high starting point for the S&P 500 left less room for the kind of rally seen when President Trump was first inaugurated in 2016. Strong profit growth among the Magnificent 7 had driven performance, and while not necessarily a bubble, we did believe this growth appeared to be priced in.

Nonetheless, the US market has continued to rise and is now the most expensive region, representing two-thirds of market capitalisation. In our view, this makes it the key risk to watch. The trade tariff uncertainty in April was a stark reminder of how vulnerable the market can be, and how quickly it can react to shocks. A range of factors – be it an economic shift, a company-specific issue, or a currency movement (especially a stronger US dollar) – could trigger a correction.

Much of the US market’s resilience is underpinned by the continued growth of large tech companies, which have significant pricing power. Understanding these businesses is therefore vital to understanding this market.

2. The UK market is well priced, without obvious catalysts

When creating this assumption at the outset of the year, UK equities had lagged global markets for more than a decade. While the outlook for the UK remained mixed, attractive valuations offered a compelling case for long-term investors. In our view, the market appeared heavily influenced by sentiment – suggesting that any improvement in perception could help close the performance gap.

The UK is currently performing broadly in line with global markets, despite persistent negative sentiment. But tight spreads and expensive valuations mean we’re relying on growth to justify future returns.

Against this backdrop, we believe UK positioning should remain dynamic rather than structural – guided by risk sources and the UK’s interaction with global markets, especially in the US.

3. Bond risks look balanced with uncertain inflation

At the start of 2025, given the uncertainty on central bank policy, inflation and growth, we believed yields could move up or down, with the yields of 4%+ providing a buffer if they did indeed rise. Credit spreads were meanwhile historically low, favouring government bonds.

In today’s environment, our bond assumptions remain valid if not more compelling than before.

Final thoughts

In a world where short-term market movements often dominate the narrative, capital market assumptions offer a valuable anchor for long-term investing. They help us look beyond the noise, providing a structured yet flexible framework to assess risk and return across asset classes.

CMAs are more than just forecasts – they’re a cornerstone of our asset allocation process. By continuously refining our assumptions and challenging our views, we aim to build resilient portfolios for our pension customers, that are well-positioned to navigate both current conditions and future uncertainties.